JAYOTI VIDYAPEETH WOMEN'S UNIVERSITY,

JAIPUR
Government of Rajasthan established
Through ACT No. 17 of 2008 as per UGC ACT 1956
NAAC Accredited University
Faculty of Education and Methodology
Faculty Name- JV’n Dr. Md Meraj Alam

Program- BA B.Ed 3rd Semester

Course- Macroeconomics

Digital session name – Classical Theory of Employment

Introduction:
John Maynard Keynes in his General Theory of Employment, Interest and Money published
in 1936, made a frontal attack on the classical postulates. He developed a new economics
which brought about a revolution in economic thought and policy.

The General Theory was written against the background of classical thought. By the
“classicists” Keynes meant “the followers of Ricardo, those, that is to say, who adopted and
perfected the theory of Ricardian economics.” They included, in particular, J.S. Mill,
Marshall and Pigou.
Keynes repudiated traditional and orthodox economics which had been built up over a
century and which dominated economic thought and policy before and during the Great
Depression. Since the Keynesian Economics is based on the criticism of classical economics,
it is necessary to know the latter as embodied in the theory of employment.

The Classical theory of Employment.

The classical economists believed in the existence of full employment in the economy. To
them, full employment was a normal situation and any deviation from this regarded as
something abnormal. According to Pigou, the tendency of the economic system is to
automatically provide full employment in the labour market when the demand and supply of
labour are equal.
Unemployment results from the rigidity in the wage structure and interference in the working
of free market system in the form of trade union legislation, minimum wage legislation etc.
Full employment exists “when everybody who at the running rate of wages wishes to be
employed.”
Those who are not prepared to work at the existing wage rate are not unemployed because
they are voluntarily unemployed. Thus full employment is a situation where there is no
possibility of involuntary unemployment in the sense that people are prepared to work at the
current wage rate but they do not find work.

The basis of the classical theory is Say’s Law of Markets which was carried forward by
classical economists like Marshall and Pigou. They explained the determination of output
and employment divided into individual markets for labour, goods and money. Each market
involves a built-in equilibrium mechanism to ensure full employment in the economy.

Assumptions
The classical theory of output and employment is based on the following assumptions:
 There is the existence of full employment without inflation.
 There is a laissez-faire capitalist economy without government interference.
 It is a closed economy without foreign trade.
 There is perfect competition in labour and product markets.
 Labour is homogeneous.
 Total output of the economy is divided between consumption and investment
expenditures.
 The quantity of money is given and money is only the medium of exchange.
 Wages and prices are perfectly flexible.
 There is perfect information on the part of all market participants.
 Money wages and real wages are directly related and proportional.
 Savings are automatically invested and equality between the two is brought about by
the rate of interest
 Capital stock and technical knowledge are given.
  The law of diminishing returns operates in production.
 It assumes long run.

Explanations of the theory

The determination of output and employment in the classical theory occurs in labour, goods
and money markets in the economy.
Say’s Law of Markets:
Say’s law of markets is the core of the classical theory of employment. An early 19th century
French Economist, J.B. Say, enunciated the proposition that “supply creates its own
demand.” Therefore, there cannot be general overproduction and the problem of
unemployment in the economy.
If there is general overproduction in the economy, then some labourers may be asked to leave
their jobs. The problem of unemployment arises in the economy in the short run. In the long
run, the economy will automatically tend toward full employment when the demand and
supply of goods become equal.
When a producer produces goods and pays wages to workers, the workers, in turn, buy those
goods in the market. Thus the very act of supplying (producing) goods implies a demand for
them. It is in this way that supply creates its own demand.
Determination of Output and Employment:
In the classical theory, output and employment are determined by the production function
and the demand for labour and the supply of labour in the economy. Given the capital stock,
technical knowledge and other factors, a precise relation exists between total output and
amount of employment, i.e., number of workers. This is shown in the form of the following
production function: Q=f (K, T, N)
where total output (Q) is a function (f) of capital stock (K), technical knowledge (T), and the
number of workers (N)
Given K and T, the production function becomes Q = f (AO which shows that output is a
function of the number of workers. Output is an increasing function of the number of
workers, output increases as the employment of labour rises. But after a point when more
workers are employed, diminishing marginal returns to labour start.
This is shown in Fig. 1 where the curve Q = f (N) is the production function and the total
output OQ1 corresponds to the full employment level NF. But when more workers NfN2 are
employed beyond the full employment level of output OQ 1, the increase in output Q1Q2 is
less than the increase in employment N1N2.

Source: Internet